It’s A Big Investing World Out There

This article “It’s A Big Investing World Out There” by Cai HaoXiang was first published in The Business Times on 15 Feb 2016 and is reproduced in this blog in its entirety.

Novice investors should expand their horizons and not confine themselves to just the Singapore market.

Some 25 years ago, I remember going to a pizza restaurant with my family. You might have heard of it. It’s called Pizza Hut. As a child, I remember being awed by its all-you-can-eat buffet. I stuffed myself so much that I could barely move after the meal.

For me then, pizza was a delicacy. We ate there only on special occasions. The food concept was new: who knew you could put cheese, tomato sauce and a bunch of other meats or vegetables on top of baked bread?

Today, the all-you-can-eat Pizza Hut buffet is long gone in Singapore, along with the mystique of eating pizza. Yet in many other places, the buzz of pizza – and Pizza Hut – has yet to fade.

This brand had made pizza famous around the world. In China, Pizza Hut – known as bi sheng ke – has gained a reputation for being an upscale restaurant with a rather extensive menu. It has a presence in hundreds of cities, and is fast expanding.

Nearly 300 Pizza Hut restaurants were opened in the last three months of 2015 alone, taking the total number of outlets in the country to more than 1,500. Its home delivery segment is also growing fast.

You can also order anything from American breakfasts and waffles to porridge, fishball noodles and fried rice.

In the US, where I studied for a few years, Pizza Hut has been losing market share to competitors such as Domino’s. Yet, if the brand fights back well enough, the market is established enough for profits to come back.

Delivered pizza, for example, is the junk food of choice for hungry, lazy, and budget- conscious students. People order it at every student event. You could keep old pizza slices in the fridge for a long time, microwaving them whenever you got hungry late at night while cramming for final exams.

What does all this have to do with investing? When we buy stocks, we are essentially buying a fractional entitlement to a living, breathing business. For the business to make money, we need to make sure it sells things that people want to buy.

There is nothing as essential as food.

And in a hyper-competitive food market, where anybody can make his own food and anybody can set up a stall selling it, the most profitable food businesses investors can own will be global brands that have established themselves over decades.

Fancy Some Fried Chicken?

Perhaps you might not like pizza, but you might have tasted the delights of fried chicken at some point. Chicken is one of the most versatile meats, and not just in the different ways that you can cook it.

You’d be hard pressed to find a religion that bans its consumption, for example.

What brand springs to mind when you think of chicken? There’s a little chain out there. You might have heard of it. It’s called Kentucky Fried Chicken, or KFC.

There are 5,000 KFC restaurants in China alone. Elsewhere in the world, there are 15,000 more.

Now, here’s a fun fact.

Did you know Pizza Hut and KFC are owned by the same company? And that this company – Yum! Brands – was once part of PepsiCo, the American multinational that currently also owns, oh, Pepsi, Quaker Oats, 7Up, and Lay’s potato chips?

If you are new to investing, you might start rummaging in the dusty drawers of the Singapore stock market, looking at companies selling tens of millions of dollars’ worth of chilli crabs, Chinese seafood, soup, pork floss buns and curry puffs every year.

But you will be doing yourself and your portfolio a huge disservice if you ignore the truly international brands making tens of billions of dollars in revenue a year from outlets in every corner of the globe.

Yum itself, for example, is part of a bevy of US-listed restaurant stocks that include Domino’s, Dunkin’ Brands, McDonald’s, Panera Bread, Starbucks, and The Cheesecake Factory. On the market, these companies are worth billions to dozens of billions of dollars, with McDonald’s, Starbucks and Yum among the largest.

It is in stocks like these – whose established, profitable business models have stood the test of time – that conservative- minded novice investors should think about putting a small sum of money.

Not Cheap – But You Can Never Get Them Cheap

Unfortunately, everybody else in the world thinks the same way, so these stocks don’t come cheap.

You know the Warren Buffett adage made famous after his 1989 shareholder letter: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

For the best businesses in the world, just buying them at an average price is enough; you’re never going to get them cheap. Everybody else in the world who is moderately serious about investing also knows that Buffett adage and will always act on it.

If enough people believe that there is a reasonably high probability of the KFC brand staying strong for decades to come (like how McDonald’s has thrived for generations), there is almost no chance that a business like Yum will ever trade at a single-digit earnings multiple – one benchmark of what makes a stock “cheap”.

The average long-term earnings multiple of stocks such as Yum and PepsiCo, for example, is closer to 20. It will take a rare disaster or financial crisis for these stocks to trade in the mid-teens.

How can you buy a business at an earnings multiple of 20 and still get a good deal?

When the underlying business grows its earnings at 10 per cent a year for even seven years, you will have almost doubled your return on investment if the multiple people ascribe to earnings stays the same.

And this is how some of these stocks have managed their outsized returns through the years.

The key to investing that Mr Buffett discovered is not to look at the earnings multiple alone; the secret lies in being able to assess the long-term earnings potential of a company.

Mr Buffett said something else in that same letter: “Good jockeys will do well on good horses, but not on broken-down nags . . . I’ve said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”

Good CEOs come and go. But if the underlying brand is sound, it will take severe technological change before the firm is destroyed. Spare a thought for Kodak, dominant for a hundred years, before digital photography finally destroyed the photographic film maker.

Yum is far less dominant than Kodak was in its heyday, and it can also lose its market position one day. After all, who eats at Pizza Hut regularly in Singapore nowadays? There are so many competing chains around.

It is no secret that the brand needs a major overhaul to keep it going for decades to come.

KFC is still going strong – for now. But there’s no telling, in this age of viral social media, if a rival chicken shop will eventually gain prominence and dethrone the established titan.

An Interesting Moment

I am highlighting Yum along other stocks holding international brands because a decline has finally begun in Western markets, seven years after a long bull market took root there.

While many of these stocks are still trading at historically expensive levels, I am looking out for opportunities to snag them for my long-term portfolio, especially when a global downturn hits such that valuations will be impacted in a meaningful way.

There are also specific catalysts that could boost these stocks.

Yum, for example, is planning to spin off its riskier but profitable China division. There are also murmurs around what to do with its Taco Bell division, which derives most of its profit from the US.

The company has taken on a bit more debt than I’m comfortable with, but it still looks financially strong.

Over the next few months, this column will refresh our annual series of articles on reading financial statements, targeted at the beginner investor. Companies such as Yum will feature in them.

We might not have pizza buffets here anymore. But, armed with the right knowledge, we will find that there is a buffet of stocks to feast on when the time comes.